The following chart shows an inverse head and shoulders breakout in the S&P. Given that currencies like to trail equities, this suggests that we could see further gains in the EUR/USD and maybe even USD/JPY.

Last week, I wrote that shorting AUD/NZD is my favorite trade. At that time, I said that if the currency pair rallies back above 1.31, then the uptrend has resumed and my call is wrong. However, AUD/NZD tortured me and came within 2 pips of 1.31 (1.3098) before reversing sharply lower. There is no major support in the currency pair until 1.2775, but as indicators adjust to the movements in price, so have support levels. The 1.2850 level is now the new support and that’s where I am targeting.

On a side note, I am kicking myself for not posting an official call because the moves have become deeply oversold in these currencies. However I think USD/CAD is going test parity (currently at 1.0105) and EUR/GBP is could fall to at least 0.8915 (now 0.8975).

For the past four trading days, the British pound has been stuck in a 200 pip range against the U.S. dollar and a 115 pip range against the Euro. However the bottom of the range in both the GBP/USD and EUR/USD have been broken, leading currency traders to wonder if the larger range will be tested as well. For the GBP/USD, this would be a break of the 1.6750 or 1.60 level and for EUR/GBP, the levels to watch are 85 and 87 cents.

Despite the 1 percent drop in the EUR/USD today, the GBP/USD has been relatively unchanged. One month GBP/USD volatilities have fallen to the lowest level since September 2008. Such a sharp contraction in volatility usually suggests that a breakout is imminent. The only question is, in which direction. Here are some sound arguments in favor of an upside or downside breakout.

Arguments for upside breakout in GBP/USD

– Housing market continues to show signs of stabilization, house prices rise for first time in 2009
– Break of 86 cents in EUR/GBP could lead to GBP buying
– Ascending triangle formation
– Moving averages are in “perfect order” which favor a new uptrend

The 95 price level for USD/JPY has served as very strong support over the past few months and now that the currency pair is trading well below that price level, it appears that the floor is caving in.

The following chart illustrates the significance of the breakdown. USD/JPY is trading in sell zone, which we determine using Bollinger Bands and the break of the 50% Fibonacci retracement of the January to April rally that took the currency pair from 87 to 101. The 10-day SMA is also crossing into the 200-day SMA suggests that USD/JPY could fall as low as 93.

What is driving the move in USD/JPY?

Yesterday, I posted a chart of the correlation between USD/JPY and U.S. Stocks. The S&P 500 erased its earlier gains and is now trading in negative territory which explains the latest breakdown in the currency pair. Here’s another interesting chart that confirms my belief that USD/JPY is headed lower. Three month LIBOR rates are slipping and USD/JPY has an uncanny way of trailing short term rates.